Is This The High Water Mark For Retailer Milk Pools?

Last week, Dairy Crest announced a new milk price formula, offering a cross between a market related and a cost of production price, tracking five commodity prices and adjusting the price they pay farmers as these commodities move. It is yet another twist in the tale of the growing number of UK milk pools.

Most retailers also operate these aligned pools, made up of farmers who are paid a premium directly, or indirectly, by the retailer. The benefits to the retailer include enhanced Corporate Social Responsibility credentials, a secure and high quality milk supply and greater control over the dairy supply chain. Over 25% of milk produced in the UK goes into these pools, with the huge majority processed by Arla, Dairy Crest and Muller Wiseman Dairies. As the UK liquid milk market is highly concentrated, when these retailer contracts are tendered, much is at stake.

Retailer contracts typically work on a cost plus system with farm input costs calculated independently and the milk price fixed so that the farmer receives a defined rate of return. Retailer contracts tend to pay farmers a pence per litre of milk that is at the very top of what is available in the UK. The top three current best milk prices in the UK are contracts from M&S, Tesco and Sainsbury’s. Farmers also benefit from animal husbandry, vet services and procurement savings. In turn, they are expected to invest in their herds and parlors to increase both output and quality to make milk collections on farm easier.

Aligned milk pools aren’t that new, as in FMCG Kraft, Cadbury and Nestle operate bespoke pools using a price formula. However, within the price sensitive foodservice sector, there are the first stirrings of consumer interest in the source and provenance of the milk used and what price the farmer receives. Ultimately, is likely to be sober calculations about likely consumer and end user reaction and opinion that will dictate the pace of any moves to foodservice pools.

Seen through a global lens, UK retailer milk pools appeal to farmers precisely because UK dairy is relatively inefficient compared to other dairy exporting nations. Take the New Zealanders, blessed with well-invested farms and supply chains, a perfect dairying climate and acres of land. It is very unlikely that these farmers would be interested in cost-plus pricing from a retailer because their costs of production are so low. Their cows graze on grass, which is about as cheap as it gets. Kiwi farmers feel they can secure export prices which will be way ahead of their cost base.

Could this ever happen in the UK? Well, it might not be that far off. It depends whether you are bullish or bearish about UK Dairy. Bulls cite the stability that the large liquid market gives by consuming half of all milk supplies, consistent growth in UK dairy consumption, initiatives like the Milk Marketing Forum, growth in cheese exports of 25% in the last 5 years and a growing consumer preference for British provenance. Bears point to overcapacity in the competitive middle ground of milk processing, a relative lack of investment in assets, consumer scepticism about larger and more efficient farms and the threat of Irish expansion into the UK.

If you sympathise with the Bulls, you can envisage a situation whereby UK processors feel they have to pay a premium over retailer pool prices in order to guarantee a steady milk supply. Farmers could then feel that by pegging their prices to the costs of production via one of the retailer contracts, their profit would be capped. If this analysis is right, then we may be approaching the high water mark for retailer milk pools. If, on the other hand you are a Bear, then retailer pools may have much further to go yet, into Foodservice and other areas.

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